Comparative Financial Systems: A Survey 1 What is a Financial System? The purpose of a financial system is to channel funds from agents with surpluses to agents with deficits. In the traditional literature there have been two approaches to analyzing this process. The first is to consider how agents interact through financial markets. The second looks at the operation of financial intermediaries such as banks and insurance companies. Fifty years ago, the financial system could be neatly bifurcated in this way. Rich households and large firms used the equity and bond markets, while less wealthy households and medium and small firms used banks, insurance companies and other financial institutions. Table 1, for example, shows the ownership of corporate equities in 1950. Households owned over 90 percent. By 2000 it can be seen that the situation had changed dramatically. By then households held less than 40 percent, nonbank intermediaries, primarily pension funds and mutual funds, held over 40 percent. This change illustrates why it is no longer possible to consider the role of financial markets and financial institutions separately. Rather than intermediating directly between households and firms, financial institutions have increasingly come to intermediate between households and markets, on the one hand, and between firms and markets, on the other. This makes it necessary to consider the financial system as an irreducible whole. The notion that a financial system transfers resources between households and firms is, of course, a simplification. Governments usually play a significant role in the financial system. They are major borrowers, particularly during times of war, recession, or when large infrastructure projects are being undertaken. They sometimes also save significant amounts of funds. For example, when countries such as Norway and many Middle Eastern States have access to large amounts of natural resources (oil), the government may acquire large trust funds on behalf of the population. In addition to their roles as borrowers or savers, governments usually play a number of other important roles. Central banks typically issue fiat money and are extensively involved in the payments system. Financial systems with unregulated markets and intermediaries, such as the US in the late nineteenth century, often experience financial crises (Gorton (1988) and Calomiris and Gorton (1991)). The desire to eliminate these crises led many governments to intervene in a significant way in the financial system. Central banks or some other regulatory authority are charged with regulating the banking system and other intermediaries, such as insurance companies. So in most 1 countries governments play an important role in the operation of financial systems. This intervention means that the political system, which determines the government and its policies, is also relevant for the financial system. There are some historical instances where financial markets and institutions have operated in the absence of a well-defined legal system, relying instead on reputation and other implicit mechanisms. However, in most fi- nancial systems the law plays an important role. It determines what kinds of contracts are feasible, what kinds of governance mechanisms can be used for corporations, the restrictions that can be placed on securities and so forth. Hence, the legal system is an important component of a financial system. ......